Australia | May 17 2018
Innovation remains a central theme at packaging business Orora. Brokers are confident in the expectations for Australasia while North America remains challenged and there is potential for further investment in that division.
-Investing in innovation to deflect rising costs
-Strong growth in Australasian glass business
-Potential for further US acquisitions
By Eva Brocklehurst
Packaging business Orora ((ORA)) has provided insight into its plans for growth in the Australasian business, showcasing its solutions as well as a new state-of-the-art digital printer and laser cutter, one of the first of its kind in the world.
CLSA believes the company is well-placed for further steady earnings growth and warrants a premium valuation. Innovation remains the central theme, ensuring the long-term strategy is not overly dependent on acquisitions.
While CLSA, not one of the stockbrokers monitored daily on the FNArena database, is comfortable on the outlook, as the stock has materially outperformed the broader market since FY17, an Underperform rating is maintained. Target is $3.30.
Credit Suisse believes management is taking a proactive approach by investing in innovation to deflect rising costs. As the company is making such investments the broker suggests Orora is unlikely to win in the "price" segment of the market, preferring a strategy of differentiation, particularly in Australasian fibre.
The commentary has not induced the broker to make material changes to earnings and valuation. The trading multiple is now closer to that of Amcor ((AMC)), which is a globally diverse packaging company that arguably supports a higher multiple. Credit Suisse believes Amcor's trading multiple would represent somewhat of a ceiling for Orora.
The glass business has grown strongly and management has announced an investment of $35m towards a new warehouse in South Australia, to be completed by the first half of 2020 with a targeted return on investment of 15%.
Such investments suggest that the company is willing to maintain a competitive advantage and Morgans remains confident in the long-term growth prospects. Ord Minnett, too, is more confident in the growth expectations for the Australasian division and believes there is upside to earnings estimates.
The company's investment in the new glass warehousing capacity can be justified, in the broker's opinion, because of growth in the export market for Australian bottled wine. Orora has renewed its contract with the largest glass customer for another four years and will supply high-end bottles with anti-counterfeit features.
Orora has also signed a long-term renewable energy agreement with a new wind farm in Victoria, complementing the one signed in the first half with Pacific Hydro in South Australia. This is expected to reduce annual energy costs to around $7m from $12-16m. The energy deals mean 80% of the company's electricity requirements in Australia will be generated from renewable sources.
Meanwhile, the company is expecting its B9 plant will achieve 400,000 tonnes of production this year and, in successive years, can be engineered for 1-2% of incremental capacity per annum. This makes Credit Suisse confident in its forecasts for 5.6% growth in operating earnings for Australasian fibre in FY19.
There is also diminished sensitivity in the second half from changes in commodity costs, secured by locking in longer-term arrangements in a more advantageous local market. Credit Suisse calculates this achieves savings of $2.5m in the second half but has a minimal impact in the first half of FY19.
In contrast, growth prospects in North America are softer. Some enterprise software systems problems at the Orora Packaging Solutions business has resulted in slower growth versus historical rates. The roll out of the system (SAP) is now almost complete and M&A opportunities are back in focus, although management has reiterated its intention to retain a disciplined approach.
Morgans believes the issues in North America are of a short-term nature and once the roll out is complete by August performance should improve.
Events such as Toys 'R' Us going into administration has also had a negative impact on earnings. The bad debt (Toys 'R' Us) at Orora Visual has exacerbated the risks and the provision has grown to US$2.5m from US$1.0m.
Credit Suisse conservatively models 2.0% sales growth in North America in FY19, less than the company is targeting because of this lost customer sales account. Credit Suisse models earnings expansion in the second half of 7.2% and projects a further increase to 7.7% in FY19 as Orora extracts synergy from its Orora Visual acquisitions.
Macquarie expects organic earnings and initiatives should mean growth continues, while there is potential for acquisitions, suspecting more activity over the next six months. There is steady progress on integration at Orora Visual although more work is required to get the business into shape, in the broker's view.
End markets remain challenged for growth in North America, yet Ord Minnett agrees there is potential for investment in the division.
Management has acknowledged it could take some time to pass through the recent paper price increase to customers and, similar to other industrial and distribution businesses in the US, rising freight rates may also challenge margins for the operations in the near term.
There are four Buy ratings and three Hold on FNArena's database. The consensus target is $3.50, suggesting 0.7% upside to the last share price.
Disclaimer: The writer has shares in the company.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.